Analysis by the Fraser of Allander Institute
Many had anticipated that the Chancellor would use today’s Spring Statement to announce a more targeted package of support for lower-income households than he had in February. Instead, the Chancellor used it to reiterate his emphasis on fiscal prudence whilst promising an income tax cut in 2024.
The surprise (1): no targeted support
There was a broad expectation that Sunak would use today’s announcement to announce financial support for lower income households, probably via additional spending on social security. There was certainly a very strong case for him doing so.
Part of the reason why the current spike in inflation is creating a cost of living crisis is that the inflationary rise has happened so suddenly that normal benefit uprating policy is out of touch with reality. Benefits are normally uprated in April each year in line with inflation. But the measure of inflation used is from September the previous year.
In September, inflation was running at 3.1%. By February it was 6.2%. It is forecast to average 7.4% in 2022 (peaking at 8.7%). This means big real terms cuts for benefits in 2022, potentially followed by a big upswing in 2023, as uprating catches up with reality.
Households, particularly low income households, are not well placed to deal with such volatility. But governments are. Addressing this disconnect would have been relatively easy, and fiscally neutral in the medium term.
Surprisingly, the Chancellor offered nothing on social security. The cost of living crisis will affect lower income households much more acutely than those on middle or higher incomes.
Spending on energy and food makes up a higher share of their incomes; they less ability to absorb cost increases via savings; and they have fewer options to make savings by switching to lower priced product lines. There does not appear to be much consideration of the distributional dimension to this crisis.
The only attempt at targeting towards the most financially constrained was an additional £500m for local authorities to distribute to households most in need. The Scottish Government will receive a Barnett consequential as a result (likely to be around £50m). But this is a small amount of support in the context of the scale of the problem.
… but more broad-based support
Instead, Sunak’s support for households was again broad-based. The main element was a 5p cut in fuel duty. This is very weakly progressive as a policy – low income households spend proportionately more of their income on petrol than higher income households – but it provides a larger cash boost to high income households. And, by spreading support so thinly, the £5bn cost of this policy will provide limited relief to households most financially exposed to the rise in the cost of living. (If it provides much relief at all – how much of the 5p cut might be passed on to consumers is unknown).
The Chancellor chose not to postpone the increase in employee and employer NICs that was announced in September. This in itself was sensible – postponing the rise would mainly have benefitted higher earners. Furthermore, there would be a real risk that a one-year postponement could evolve into a permanent postponement as the election gets closer and the memory of the pandemic – used in part as justification for the NICs rise – fades
But what he did do was increase the threshold at which NICs is due, from £9,900 that was pencilled in for 2022 to £12,570 (bringing forward a sensible commitment to align the threshold with the income tax personal allowance). This increase in the threshold is worth just over £300 per year for employees. The effect is to offset the impact of the increase in NICs rate for the majority of earners in 2022. The cost of the measure in 2022 is £6bn.
The surprise (2): Income tax cut in 2024
Chancellors traditionally leave their flagship policy announcement until the end of their speech. Sunak’s flagship today was a promise to cut the basic rate of income tax from 20p to 19p in 2024.
The economic rationale for this is far from clear. The rise in employee and employer NICs (and subsequent health and social care levy) was justified by the need to address long-term fiscal challenges resulting from an ageing population and a smaller economy (thanks to Brexit and Covid).
But the proposed income tax cut will offset most of the impact of the Health and Social Care Levy on revenues. The outcome of the two policies together – the income tax cut and NICs rise – is to transfer the burden of tax from pensioners, landlords and others with unearned income to earners.
The proposed income tax cut will not apply in Scotland (a small caveat to this is that the income tax rate on savings will be cut to 19p UK-wide, since it is not devolved). Instead, the Scottish Government will, in 2024, receive an increase in its block grant which is broadly equivalent to the costs of a 1p reduction in the UK basic rate in Scotland.
The Scottish Government will be free to decide how to allocate this additional resource – whether that be through tax cuts of its own, or higher spending on public services. The politics of this will be interesting.
Summary
This was not the set of measures that many people had expected or hoped for. 2022 is set to see the biggest single-year fall in real household disposable income since records began in the late 1950s, according to the OBR.
The main policy measures announced today for 2022 were the 5p fuel duty cut, which will make little difference to the households most exposed to the crisis; and the rise in the NICs thresholds, which ensures that the government’s tax rise will not add to the cost of living burden this year for most earners.
These policies of course have to be seen alongside February’s £9bn package – which included the £150 grants to households in council tax bands A-D, and a £200 reduction in energy bills in 2022 (repayable in future years).
In combination, the announcements in February and March equate to some £17.6bn of support for household incomes in 2022/23. This includes £3bn on grants via council tax, £2.4bn through fuel duty cuts, £6.3bn through raising the primary NICs threshold, and £6bn of direct support for energy bills which is recouped in the subsequent five years.
On one level this is a generous package of support. But it has to be seen within the context of an substantial and sudden shock to living standards. The government is in a better position to smooth the impacts of this shock that individual households, particularly those on the lowest incomes.
But across the two announcements, there has been no targeted support to the lowest income households. As a result, benefits are set to rise 3.1% in April, against a forecast inflation rate in 2022 of 7.4% – a real terms cut in benefits of 4% (or more, when we factor in low income households higher proportionate spending on energy and food).
This outcome could have been avoided relatively costlessly by adapting standard benefit uprating rules. There is certainly no sense in which such a measure could not have been ‘afforded’, even within the Chancellor’s own fiscal rules.
There was also no extra spending on public services. This means that the cash allocations set out in last year’s Spending Review are now worth less in real terms. Public departments face rising costs of energy too, and meeting these costs within existing budgets will mean less for other things.
Rishi Sunak is rapidly repainting the image he carved for himself during the pandemic. Gone is the priority to ‘do whatever it takes’. It is replaced by a reiteration of his desire to meet his own fiscal rules, whilst pencilling in a flagship cut to income tax.
The political calculation is that the promise of tax cuts and fiscal prudence will appeal to the core elements of the electoral base.
But this may yet prove a risky strategy. In the meantime, 2022 is set to be an extremely tough year for many households.
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